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Xref: bloom-picayune.mit.edu misc.invest:33569 news.answers:4572 Newsgroups: misc.invest,news.answers Path: bloom-picayune.mit.edu!enterpoop.mit.edu!ira.uka.de!rz.uni-karlsruhe.de!stepsun.uni-kl.de!uklirb!bogner.informatik.uni-kl.de!lott From: lott@informatik.uni-kl.de (Christopher Lott) Subject: misc.invest FAQ on general investment topics (part 1 of 2) Message-ID: <invest-faq-p1_724309206@informatik.uni-kl.de> Followup-To: misc.invest Summary: Answers to frequently asked questions about investments. Should be read by anyone who wishes to post to misc.invest. Originator: lott@bogner.informatik.uni-kl.de Keywords: invest, stock, bond, money, faq Sender: news@uklirb.informatik.uni-kl.de (Unix-News-System) Supersedes: <invest-faq-p1_723127741@informatik.uni-kl.de> Nntp-Posting-Host: bogner.informatik.uni-kl.de Reply-To: lott@informatik.uni-kl.de Organization: University of Kaiserslautern, Germany Date: Mon, 14 Dec 1992 05:00:14 GMT Approved: news-answers-request@MIT.Edu Expires: Mon, 11 Jan 1993 05:00:06 GMT Lines: 967 Archive-name: investment-faq/general/part1 Last-modified: Mon Dec 14 06:00:02 MET 1992 Compiler: Christopher Lott, lott@informatik.uni-kl.de This is the general FAQ for misc.invest, part 1 of 2. This FAQ discusses issues pertaining to money and investment instruments, specifically stocks, bonds, and things like options and life insurance. For extensive information on mutual funds, see the mutual fund FAQ, which is posted regularly to misc.invest and maintained by timlee@btr.btr.com Subjects more appropriate to misc.consumers are not included here. Disclaimers: This information is guaranteed to change over time and is probably out of date already. Mention of a product does not constitute an endorsement. Answers to questions closer to the bottom of the list may rely on information given in prior answers. Readers outside the USA should not necessarily rely on US-800 telephone numbers. All prices are listed in US dollars unless otherwise specified. This FAQ is freely distributable, is posted every 14 days, and is available from the news.answers archive on host rtfm.mit.edu. Using FTP, fetch the files "/pub/usenet/news.answers/investment-faq/general/*" If you don't have FTP access, send an e-mail request to "mail-server@rtfm.mit.edu" with the body "send usenet/news.answers/investment-faq/general/*" No other FTP archive is currently known to the compiler for misc.invest information and programs. Please send comments and new submissions to the compiler. ----------------------------------------------------------------------------- TABLE OF CONTENTS FOR THIS PART Sources for Historical Stock Information Beginning Investor's Advice American Depository Receipts (ADR) Beta Books About Investing (especially stocks) Bull and Bear Lore Computing the Rate of Return on Monthly Investments Computing Compound Return Discount Brokers Dollar Cost and Value Averaging Direct Investing and DRIPS Future and Present Value of Money How Can I Get Rich Really Quickly? Hedging Investment Associations (AAII and NAIC) Life Insurance ----------------------------------------------------------------------------- Subject: Sources for Historical Stock Information From: bakken@cs.arizona.edu, nfs@princeton.edu, gary@intrepid.com, discar@nosc.mil, irving@Happy-Man.com, ddavis@gain.com, krshah@us.oracle.com There are no free sources for historical stock information on the Internet. Paid services include: + Prodigy. US$13/month for basic service includes 15 minute delayed quotes on stocks at NO additional charge. Available via local dial-up all over the US. + Compuserve. US$7.95/month for basic service includes 15-mi delayed quotes on stocks and options at no additional charge. Historical quotes are available for an additional charge. Available via local dial-up all over the US. + Genie. US$4.95/month for today's closing quotes. Genie Professional service (price not given) gives historical quotes, stock reports, different investment s/w, access to Charles Schwab and online trading. + Farpoint. ($4 or $8/week for an IBM-compatible diskette) provides daily high, low, close, and volume for for approximately 6000 stocks. They offer historical data from 1 July 89 to present. Write to Farpoint, 3412 Milwaukee Avenue, Suite 477, Northbrook, Illinois 60062. + Historical Data Services in Kansas City, MO. They carry stock quotes, commodities, indexes, mutual funds. Daily stock quotes, per year: $0.75 Contact them at 800-677-7369. + Dow Jones News Retrieval. Stock, bond, mutual, index quotes as well as news articles on companies, and misc. analysis packages. US $25 per month flat rate for the after hours service (8pm-5am local time). Available via dailup over Tymnet and SprintNet; available via Internet. + Standard & Poor's Compustat (most complete and most expensive). + Disclosure's "Compact Disclosure" on CD (only $6,000 a year). + Value Line's Database Bulletin Boards for historical stock information include: + The Farpoint BBS in Chicago keeps about 3 years back data on a boatlaod of stocks. Free use up to 2 hours a day, they ask for a contribution. Quotes updated weekly. [ Phone number? ] + The Business Center BBS in San Diego carries most issues on the NYSE, NASDAQ, and AMEX. It is free but limits on-line time to 20 minutes. Phone number is +1 (619) 482-8675. [ Compiler's note: Anyone have a list of other sources? ] ----------------------------------------------------------------------------- Subject: Beginning Investor's Advice From: pearson_steven@tandem.com, egreen@east.sun.com Investing is just one aspect of personal finance. People often seem to have the itch to try their hand at investing before they get the rest of their act together. This is a big mistake. For this reason, it's a good idea for "new investors" to hit the library and read maybe read three different overall guides to personal finance - three for different perspectives, and because common themes will emerge (repetition implies authority?). Anyway, what I'm talking about are books like: Madigan and Kasoff, The First-Time Investor, ISBN 0-13-942376-1 Andrew Tobias, [Still] the Only [Other] Investment Guide You Will Ever Need. (3 versions with slightly different titles, all very similar.) Sylvia Porter's Money magazine's Money Guide Another good source is the Mutual Fund Education Alliance (MFEA); write them at MFEA, 1900 Erie Street, Suite 120, Kansas City, MO 64116. What I am specifically NOT talking about is most anything that appears on a list of investing/stock market books that are posted in misc.invest from time to time. You know, Market Logic, One Up on Wall Street, Beating the Dow, Winning on Wall Street, The Intelligent Investor, etc. These are not general enough. They are investment books, not personal finance books. Many "beginning investors" have no business investing in stocks. The books recommended above give good overall money management, budgeting, purchasing, insurance, taxes, estate issues, and investing backgrounds from which to build a personal framework. Only after that should one explore particular investments. If someone needs to unload some cash in the meantime, they should put it in a money market fund, or yes, even a bank account, until they complete their basic training. While I sympathize with those who view this education as a daunting task, I don't see any better answer. People who know next to nothing and always depend on "professional advisors" to hand-hold them through all transactions are simply sheep asking to be fleeced (they may not actually be fleeced, but most of them will at least get their tails bobbed). In the long run, you are the only person ultimately responsible for your own financial situation. ----------------------------------------------------------------------------- Subject: American Depository Receipts (ADR) From: ask@cbnews.cb.att.com An American Depository Receipt is a share of stock of an investment in shares of a non-US corporation. For example, BigCitibank might purchase 25 million shares of a non-US stock. Call it EuroGlom Corporation (EGC). Perhaps EGC trades on the Paris exchange, where BigCitibank bought them. BigCitibank would then register with the SEC and offer for sale shares of EGC ADRs. EGC ADRs are valued in dollars, and BigCitibank could apply to the NYSE to list them. In effect, they are repackaged EGC shares, backed by EGC shares owned by BigCitibank, and they would then trade like any other stock on the NYSE. BigCitibank would take a management fee for their efforts, and the number of EGC shares represented by EGC ADRs would effectively decrease, so the price would go down a slight amount; or EGC itself might pay BigCitibank their fee in return for helping to establish a US market for EGC. Naturally, currency fluctuations will affect the US Dollar price of the ADR. Dividends paid by EGC are received by BigCitibank and distributed proportionally to EGC ADR holders. If EGC withholds (foreign) tax on the dividends before this distribution, then BigCitibank will withhold a proportional amount before distributing the dividend to ADR holders, and will report on a Form 1099-Div both the gross dividend and the amount of foreign tax withheld. Most of the time the foreign nation permits US holders (BigCitibank in this case) to vote their shares on all or most issues, and ADR holders will receive ballots which will be received by BigCitibank and voted in proportion to ADR Shareholder's vote. I don't know if BigCitibank has the option of voting shares which ADR holders failed to vote. Having said this, however, for the most part ADRs look and feel pretty much like any other stock. ----------------------------------------------------------------------------- Subject: Beta From: RKSHUKLA@SUVM.SYR.EDU,ajayshah@almaak.usc.edu,rbp@investor.pgh.pa.us Beta is the sensitivity of a stock's returns to the returns on some market index (e.g., S&P 500). Beta values can be roughly characterized as follows: b < 0 Negative beta is possible but not likely. People thought gold stocks should have negative betas but that hasn't been true b = 0 Cash under your mattress, assuming no inflation 0 < b < 1 Dull investments (e.g., utility stocks) b = 1 Matching the index (e.g., for the S&P 500, an index fund) b > 1 Anything more volatile than the index (e.g., small cap. funds) b -> infinity Impossible, because the stock would be expected to go to zero on any market decline. 2-3 is probably as high as you will get More interesting is the idea that securities MAY have different betas in up and down markets. Forbes used to (and may still) rate mutual funds for bull and bear market performance. Here is an example showing the inner details of the beta calculation process: Suppose we collected end-of-the-month prices and any dividends for a stock and the S&P 500 index for 61 months (0..60). We need n + 1 price observations to calculate n holding period returns, so since we would like to index the returns as 1..60, the prices are indexed 0..60. Also, professional beta services use monthly data over a five year period. Now, calculate monthly holding period returns using the prices and dividends. For example, the return for month 2 will be calculated as: r_2 = ( p_2 - p_1 + d_2 ) / p_1 Here r denotes return, p denotes price, and d denotes dividend. The following table of monthly data may help in visualizing the process. Monthly data is preferred in the profession because investors' horizons are said to be monthly. =========================================== # Date Price Dividend(*) Return =========================================== 0 12/31/86 45.20 0.00 -- 1 01/31/87 47.00 0.00 0.0398 2 02/28/87 46.75 0.30 0.0011 . ... ... ... ... 59 11/30/91 46.75 0.30 0.0011 60 12/31/91 48.00 0.00 0.0267 =========================================== (*) Dividend refers to the dividend paid during the period. They are assumed to be paid on the date. For example, the dividend of 0.30 could have been paid between 02/01/87 and 02/28/87, but is assumed to be paid on 02/28/87. So now we'll have a series of 60 returns on the stock and the index (1...61). Plot the returns on a graph and fit the best-fit line (visually or using some least squares process): | * / stock | * * */ * returns| * * / * | * / * | * /* * * | / * * | / * | | +------------------------- index returns The slope of the line is Beta. Merrill Lynch, Wells Fargo, and others use a very similar process (they differ in which index they use and in some econometric nuances). Now what does Beta mean? A lot of disservice has been done to Beta in the popular press because of trying to simplify the concept. A beta of 1.5 does *not* mean that is the market goes up by 10 points, the stock will go up by 15 points. It even *doesn't* mean that if the market has a return (over some period, say a month) of 2%, the stock will have a return of 3%. To understand Beta, look at the equation of the line we just fitted: stock return = alpha + beta * index return Technically speaking, alpha is the intercept in the estimation model. It is expected to be equal to risk-free rate times (1 - beta). But it is best ignored by most people. In another (very similar equation) the intercept, which is also called alpha, is a measure of superior performance. Therefore, by computing the derivative, we can write: Change in stock return = beta * change in index return So, truly and technically speaking, if the market return is 2% above its mean, the stock return would be 3% above its mean, if the stock beta is 1.5. One shot at interpreting beta is the following. On a day the (S&P-type) market index goes up by 1%, a stock with beta of 1.5 will go up by 1.5% + epsilon. Thus it won't go up by exactly 1.5%, but by something different. The good thing is that the epsilon values for different stocks are guaranteed to be uncorrelated with each other. Hence in a diversified portfolio, you can expect all the epsilons (of different stocks) to cancel out. Thus if you hold a diversified portfolio, the beta of a stock characterizes that stock's response to fluctuations in the market portfolio. So in a diversified portfolio, the beta of stock X is a good summary of its risk properties with respect to the "systematic risk", which is fluctuations in the market index. A stock with high beta responds strongly to variations in the market, and a stock with low beta is relatively insensitive to variations in the market. E.g. if you had a portfolio of beta 1.2, and decided to add a stock with beta 1.5, then you know that you are slightly increasing the riskiness (and average return) of your portfolio. This conclusion is reached by merely comparing two numbers (1.2 and 1.5). That parsimony of computation is the major contribution of the notion of "beta". Conversely if you got cold feet about the variability of your beta = 1.2 portfolio, you could augment it with a few companies with beta less than 1. If you had wished to figure such conclusions without the notion of beta, you would have had to deal with large covariance matrices and nontrivial computations. Finally, a reference. See Malkiel, _A Random Walk Down Wall Street_, for more information on beta as an estimate of risk. ----------------------------------------------------------------------------- Subject: Books About Investing (especially stocks) From: jhc@iris.uucp, nfs@princeton.edu, ajayshah@rcf.usc.edu, rbeville@tekig5.pen.tek.com Books are organized alphabetically by author's last name. Author Title(s) ----- -------- Peter Bernstein Capital Ideas George S. Clason The Richest Man in Babylon Burton Crane The Sophicated Investor William Donoghue No-Load Mutual Fund Guide Louis Engel How to Buy Stocks Norman G. Fosback Stock Market Logic Benjamin Graham The Intelligent Investor, Security Analysis C. Colburn Hardy The Fact$ of Life Jiler How Charts Can Help You Gerald M. Loeb The Battle for Investment Survival Peter Lynch One Up on Wall Street Burton Malkiel A Random Walk Down Wall Street Sylvia Porter New Money Book for the 80s Pring Technical Analysis Explained Claude Rosenberg Stock Market Primer L. Louis Rukeyser How to Make Money in the Stock Market Charles Schwab How to be Your Own Stockbroker John A. Straley What About Mutual Funds Andrew Tobias [Still] Only [other] Investment Guide You'll Ever Need (3 books, very similar titles) Train Money Masters, New Money Masters Venita Van Caspel Money Dynamics for the 1990s Martin Zweig Winning on Wall Street ----------------------------------------------------------------------------- Subject: Bull and Bear Lore From: keith@iscp.Bellcore.COM This information is excerpted from "The Lore and Legends of Wall Street," a book by Robert M. Sharp. During Gold Rush days in California, there were bull fights. Sometimes the bull faced a bear instead of a matador. Bulls throw the bear UP in the air using their horns to win (kill the bear); bears pull the bull DOWN to the ground to win (kill the bull). Somehow these terms became associated with the markets, probably due to trading in gold-mining stock. The terms 'bull' and 'bear' then told the market's direction. Later, Cornelius Varderbilt fought Daniel Drew for control of the Harlem Railroad. Some writer compared their fight to bull-bear fights in California. This usage apparently made the terms stick. BTW, Vanderbilt eventually won. ----------------------------------------------------------------------------- Subject: Computing the Rate of Return on Monthly Investments From: jedwards@ms.uky.edu Q: Assume $X is invested at the beginning of the year into some mutual fund or like account, with $Y added to the account every month. Now, down the road, if the value at any given month "i" is Vi, what conclusions can be drawn from it ? The relevant formula is F = P(1+i)**n - p((1+i)**n - 1)/i where F is the future value of your investment (i.e., the value after n periods), P is the present value of your investment (i.e., the amount of money you invest initially), p is the payment each period (p is negative if you are adding money to your account and positive if you are taking money out of your account), n is the number of periods you are interested in, and i is the interest rate per period. You cannot manipulate this formula to get a formula for i; you have to use some sort of iterative method or buy a financial calculator. One thing to keep in mind is that i is the interest rate *per period*. You may need to compound the rate to obtain a number you can compare apples-to-apples with other rates. For instance, a 1 year CD paying 12% interest is not as good an investment as an investment paying 1% per month for a year. If you put $1000 into each, you'll have $1120 in the CD at the end of the year but $1000*(1.01)**12 = $1126.82 in the other investment due to compounding. I always convert interest rates of any kind into a "simple 1-year CD equivalent" for the purposes of comparison. See also the 'irr' program which has been posted to misc.invest several times. ----------------------------------------------------------------------------- Subject: Computing Compound Return From: bakken@cs.arizona.edu, chen@digital.sps.mot.com To calculate the compounded return, just figure out the factor by which the investment multiplied. Say $1000 went to $3200 in 10 years. Take the 10th root of 3.2 (the multiplying factor) and you get a compounded return of 1.1233498 (12.3% per year). To see that this works, note that 1.1233498**10 = 3.2. Another way of saying the same thing: In my calculation, I assume all the gains are reinvested so following formula applies: TR = (1 + AR) ** YR where TR is total return, AR is annualized return, and YR is year. To calculate annualized return otherwise, following formula applies: AR = (10 ** (Log TR/ YR)) - 1 Thus a total return of 950% in 20 years would be equivalent of 11.914454% annualized return. ----------------------------------------------------------------------------- Subject: Discount Brokers From: davida@bonnie.ics.uci.edu, edwardz@ecs.comm.mot.com, gary@intrepid.com A discount broker is merely a way to save money for people who are looking out for themselves. According to Charles Schwab, the big difference between them and "the other guys" is that there is no analyst sitting in the back that will call you up and encourage you to purchase a stock. They have people there that can provide good financial advice--but only if you ask. If you walk in the door and say "I want to buy XXX", that's what they'll do. List of US discount brokers and phone numbers: Accutrade First National 800 762 5555 K. Aufhauser & Co. 800 368 3668 Brown & Co. 800 343 4300 Fidelity Brokerage 800 544 7272 Kennedy, Cabot, & Co. 800 252 0090 213 550 0711 Barry Murphy & Co. 800 221 2111 Norstar Brokerage 800-221-8210 Olde Discount 800 USA OLDE Pacific Brokerage Service 800 421 8395 213 939 1100 Andrew Peck Associates 800 221 5873 212 363 3770 Quick & Reilly 800 456 4049 Charles Schwab & Co. 800 442 5111 Scottsdale Securities 800 727 1995 818 440 9957 Stock Cross 800 225 6196 617 367 5700 Vanguard Discount 800 662 SHIP Waterhouse Securities 800 765 5185 Jack White & Co. 800 233 3411 Here is a table to compare commissions at various discount brokers. This is based on commission schedules gotten at various times in 1991 and 1992. These tables are for stocks only, not bonds or other investments. $2000 trades Firm 400@ 5 200@10 100@20 50@40 25@80 K. Aufhauser $ 43.49 $ 27.49 $ 25.49 $ 25.49 $ 25.49 Pacific Brokerage $ 38.00 $ 28.00 $ 28.00 $ 28.00 $ 28.00 Jack White & Co. $ 45.00 $ 39.00 $ 36.00 $ 34.50 $ 33.75 Kennedy, Cabot, & Co. $ 38.00 $ 38.00 $ 38.00 $ 23.00 $ 23.00 Bidwell & Co. $ 41.25 $ 31.25 $ 27.25 $ 25.75 $ 23.50 Quick & Reilly $ 50.00 $ 50.00 $ 49.00 $ 49.00 $ 49.00 Olde Discount $ 35.00 $ 50.00 $ 40.00 $ 40.00 $ 40.00 Vanguard Discount $ 57.00 $ 57.00 $ 48.00 $ 40.00 $ 40.00 Fidelity Brokerage $ 63.50 $ 63.50 $ 54.00 $ 54.00 $ 54.00 Charles Schwab $ 64.00 $ 64.00 $ 55.00 $ 55.00 $ 55.00 $8000 trades Firm 1600@ 5 800@10 400@20 200@40 100@80 K. Aufhauser $ 90.50 $ 61.50 $ 43.49 $ 27.49 $ 25.49 Pacific Brokerage $ 74.00 $ 63.00 $ 38.00 $ 28.00 $ 28.00 Jack White & Co. $ 81.00 $ 57.00 $ 45.00 $ 39.00 $ 36.00 Kennedy, Cabot, & Co. $ 123.00 $ 63.00 $ 38.00 $ 38.00 $ 38.00 Bidwell & Co. $ 84.75 $ 56.75 $ 45.25 $ 39.25 $ 30.25 Quick & Reilly $ 79.00 $ 79.00 $ 79.00 $ 79.00 $ 49.00 Olde Discount $ 67.50 $ 95.00 $ 70.00 $ 60.00 $ 40.00 Vanguard Discount $ 82.00 $ 82.00 $ 82.00 $ 82.00 $ 48.00 Fidelity Brokerage $ 109.00 $ 102.70 $ 102.70 $ 102.70 $ 54.00 Charles Schwab $ 120.00 $ 103.20 $ 103.20 $ 103.20 $ 55.00 $32000 trades Firm 6400@ 5 3200@10 1600@20 800@40 400@80 K. Aufhauser $ 194.50 $ 138.50 $ 90.50 $ 72.50 $ 67.50 Pacific Brokerage $ 218.00 $ 139.00 $ 91.00 $ 63.00 $ 38.00 Jack White & Co. $ 161.00 $ 97.00 $ 81.00 $ 57.00 $ 45.00 Kennedy, Cabot, & Co. $ 195.00 $ 99.00 $ 123.00 $ 63.00 $ 38.00 Bidwell & Co. $ 252.75 $ 140.75 $ 100.75 $ 88.75 $ 57.25 Quick & Reilly $ 222.00 $ 131.40 $ 131.40 $ 131.40 $ 131.40 Olde Discount $ 187.50 $ 215.00 $ 135.00 $ 115.00 $ 90.00 Vanguard Discount $ 156.00 $ 156.00 $ 156.00 $ 156.00 $ 156.00 Fidelity Brokerage $ 301.00 $ 173.00 $ 169.90 $ 169.90 $ 169.90 Charles Schwab $ 360.00 $ 200.00 $ 170.40 $ 170.40 $ 170.40 ----------------------------------------------------------------------------- Subject: Dollar Cost and Value Averaging From: suhre@trwrb.dsd.trw.com Dollar Cost Averaging purchases a fixed dollar amount each transaction (usually monthly via a mutual fund). When the fund declines, you purchase slightly more shares, and slightly less on increases. It turns out that you lower your average cost slightly, assuming the fund fluctuates up and down. Value Averaging adjusts the amount invested, up or down, to meet a prescribed target. An example should clarify: Suppose you are going to invest $200 per month and at the end of the first month, your $200 has shrunk to $190. Then you add in $210 the next month, bringing the value to $400 (2*$200). Similarly, if the fund is worth $430 at the end of the second month, you only put in $170 to bring it up to the $600 target. What happens is that compared to dollar cost averaging, you put in more when prices are down, and less when prices are up. Dollar Cost Averaging takes advantage of the non-linearity of the 1/x curve (for those of you who are more mathematically inclined). Value Averaging just goes in a little deeper when the value is down (which implies that prices are down) and in a little less when value is up. An article in the American Association of Individual Investors showed via computer simulation that value averaging would outperform dollar- cost averaging about 95% of the time. "Outperform" is a rather vague term. As best as I remember, whatever the percentage gain of dollar- cost averaging versus buying 100% initially, value averaging would produce another 2 percent or so. Warning: Neither approach will bail you out of a declining market nor get you in on a bull market. ----------------------------------------------------------------------------- Subject: Direct Investing and DRIPS From: BKOTTMANN@falcon.aamrl.wpafb.af.mil, das@impulse.ece.ucsb.edu, jsb@meaddata.com, murphy@rock.enet.dec.com DRIPS are an easy, low cost way of buying stocks. Various companies (lists are available through NAIC and some brokerages) allow you to purchase shares directly from the company. By buying directly, you avoid brokerage fees. However, you must nearly always purchase the first share through a broker or other conventional means; successive shares can then be bought directly. Shares can be purchased either through dividends or directly by sending in a check. Thus the two names for DRIP: Dividend/Direct Re-Investment Plan. The periodic purchase also allows you to automatically dollar-cost-average the purchase of the stock. The latest Money Magazine (Nov or Dec 92) reports that the brokerage house A.G. Edwards has a special commission rate for purchases of single shares. They charge a flat 16% of the share price, or about $6 for Disney. Published material on DRIPS: + _Guide to Dividend Reinvestment Plans_ Lists over a one hundred companies that offer DRIP's. The number given for the company is 800-443-6900; the cost is $9.00 (charge to CC) and they will send you the DRIPs booklet and a copy of a newsletter called the Money Paper. + _Low cost/No cost investing_ (author forgotten) Lists about 300-400 companies that offer DRIPs. + _Buying Stocks Without a Broker_ by Charles B. Carlson. Lists 900 companies/closed end funds that offer DRIPS. Included is a profile of the company and some plan specifics. These are: if partial reinvestment of dividends are allowed, discounts on stock purchased with dividends, optional cash payment amount and frequency, fees, approximate number of shareholders in the plan. [ Compiler's note: It seems to me that a listing of the hundreds or more companies that offer DRIPS belongs in its own FAQ, and I will not reprint other people's copyrighted lists. Please don't send me lists of companies that offer DRIPS. ] ----------------------------------------------------------------------------- Subject: Future and Present Value of Money From: lott@informatik.uni-kl.de This note explains briefly two concepts concerning the time-value-of-money, namely future and present value. * Future value is simply the sum to which a dollar amount invested today will grow given some appreciation rate. The formula for future value is the formula from Case 2 of present value (below), but solved for the future-sum rather than the present value. In this formulation, the appreciation rate is computed monthly. To compute the future value of a sum invested today, the formula is: fv = principal * (1 + (rrate / 100) / 12) ** (12 * termy) where principal = dollar value you have now termy = term, in years rrate = annual rate of return, in percent Example of calculating the future value of an invested sum: I invest 1,000 today at 10% for 10 years. The future value of this amount is 2707.04. * Present value is the value in today's dollars assigned to an amount of money in the future, based on some estimate of inflation and rate-of-return over the long-term. A reasonable estimate for long-term inflation is 4.5%. In this analysis, inflation is compounded yearly and rate-of-return is calculated based on monthly compounding. Two cases of present value are discussed next. Case 1 involves a single sum that stays invested over time. Case 2 involves a cash stream that is paid regularly over time (e.g., rent payments). Case 1: Present value of money invested over time. This tells you what a future sum is worth today, given some inflation rate over the time between now and the future. Another way to read this is that you must invest the present value today at the rate-of-return to have some future sum in some years from now (but this only considers the raw dollars, not the purchasing power). To compute the present value of an invested sum, the formula is: future-sum pv = -------------------------------------- (1 + (rrate/100) / 12) ** (12 * termy) where future-sum = dollar value you want in termy years termy = term, in years rrate = annual rate of return on money that you can expect, in percent Example: In 30 years I will receive 1,000,000 (a gigabuck). What is that amount of money worth today (what is the buying power) assuming a rate of inflation of 4.5%? The answer is 259,895.65 Example: I need to have 10,000 in 5 years. The present value of 10,000 assuming a rate-of-return of 8% is 6712.10. I.e., 6712 will grow to 10k in 5 years at 8%. Case 2: Present value of a cash stream. This tells you the cost in today's dollars of money that you pay over time. Usually the payments that you make increase over the term. Basically, the money you pay in 10 years is worth less than that which you pay tomorrow, and this equation lets you compute just how much. To compute the present value of a cash stream, the formula is: month = 12*termy paymt * (1 + irate/100) ** int ((month - 1)/ 12) pv = SUM ------------------------------------------------- month = 1 (1 + (rrate/100) / 12) ** (month - 1) where month = month number termy = term, in years paymt = monthly payment, in dollars irate = rate of inflation (increase in payment per year), in percent rrate = rate of return on money that you can expect, in percent int() function = keep integral part; used to compute yr nr from mo nr Example: You pay $500/month in rent over 10 years and estimate that inflation is 4.5% over the period (your payment increases with inflation.) Present value is 49,530.57 I wrote two small C programs for computing future and present value; send email to lott@informatik.uni-kl.de if you are interested. ----------------------------------------------------------------------------- Subject: How Can I Get Rich Really Quickly? From: jim@doink.b23b.ingr.com Take this with a lot of :-) 's. Legal methods: 1. Marry someone who is already rich. 2. Have a rich person die and will you their money. 3. Strike oil. 4. Discover gold. 5. Win the lottery. Illegal methods: 6. Rob a bank. 7. Blackmail someone who is rich. 8. Kidnap someone who is rich and get a big ransom. 9. Become a drug dealer. For completeness sakes: 10. "If you really want to make a lot of money, start your own religion." - L. Ron Hubbard Hubbard made that statement when he was just a science fiction writer in either the '30s or '40s. He later founded the Church of Scientology. I believe he also wrote Dianetics. ----------------------------------------------------------------------------- Subject: Hedging From: nfs@princeton.edu Hedging is a way of reducing some of the risk involved in holding an investment. There are many different risks against which one can hedge and many different methods of hedging. When someone mentions hedging, think of insurance. A hedge is just a way of insuring an investment against risk. Consider a simple (perhaps the simplest) case. Much of the risk in holding any particular stock is market risk; i.e. if the market falls sharply, chances are that any particular stock will fall too. So if you own a stock with good prospects but you think the stock market in general is overpriced, you may be well advised to hedge your position. There are many ways of hedging against market risk. The simplest, but most expensive method, is to buy a put option for the stock you own. (It's most expensive because you're buying insurance not only against market risk but against the risk of the specific security as well.) You can buy a put option on the market (like an OEX put) which will cover general market declines. You can hedge by selling financial futures (e.g. the S&P 500 futures). In my opinion, the best (and cheapest) hedge is to sell short the stock of a competitor to the company whose stock you hold. For example, if you like Microsoft and think they will eat Borland's lunch, buy MSFT and short BORL. No matter which way the market as a whole goes, the offsetting positions hedge away the market risk. You make money as long as you're right about the relative competitive positions of the two companies, and it doesn't matter whether the market zooms or crashes. ----------------------------------------------------------------------------- Subject: Investment Associations (AAII and NAIC) From: rajeeva@sco.com, dlaird@terapin.com AAII: American Association of Individual Investors 625 North Michigan Avenue Chicago, IL 60611 A summary from their brochure: AAII believes that individuals would do better if they invest in "shadow" stocks which are not followed by institutional investor and avoid affects of program trading. They admit that most of their members are experienced investors with substantial amounts to invest, but they do have programs for newer investors also. Basically, they don't manage the member's money, they just provide information. They offer the AAII Journal 10 times a year, Individual Investor's guide to No-Load Mutual Funds annually, local chapter membership (about 50 chapters), a year-end tax strategy guide, investment seminars and study programs at extra cost (reduced for members), and a computer user' newsletter for an extra $30. They also operate a free BBS. NAIC: National Association of Investors Corp. 1515 East Eleven Mile Road Royal Oak, MI 48067 1-313-543-0612 The NAIC is a nonprofit organization operated by and for the benefit of member clubs. The Association has been in existence since the 1950's and has around 110,000 members. Membership costs $32.00 per year for an individual or $30 for a club and $9.00 per each club member. The membership provides the member with a monthly newsletter, details of your membership and information on how to start a investment club, how to analyze stocks, and how to keep records. In addition to the information provided, NAIC operates "Low-Cost Investment Plan", which allows members to invest in participating companies such as Disney, Kellogg, McDonald's, Mobil and Quaker Oats... Most don't incur a commission although some have a nominal fee ($3-$5). Of the 500 clubs surveyed in 1989, the average club had a compound annual growth rate of 10.8% compared with 10.6% for the S&P 500 stock index...It's average portfolio was worth $66,755. ----------------------------------------------------------------------------- Subject: Life Insurance From: joec@is.morgan.com This is my standard reply to life insurance queries. And, I think many insurance agents will disagree with these comments. First of all, decide WHY you want insurance. Think of insurance as income-protection, i.e. if the insured passes away, the beneficiary receives the proceeds to offset that lost income. With that comment behind us, I would never buy insurance on kids, after all, they don't have income and they don't work. An agent might say to buy it on your kids while its cheap - run the numbers, the agent is usually wrong. And I am strongly against this on two counts. One, you are placing a bet that you kid will die and you are actually paying that bet in premiums. I can't bet my child will die. Two, it sounds plausible, but factor inflation in - it doesn't look so good. A policy of face amount of $10,000, at 4.5% inflation and 30 years later is like having $2,670 in today's dollars - it's NOT a lot of money. So don't plan on it being worth much in the future to your child as an investment. I have some doubts about insurance as investments - it might be a good idea but it certainly muddies the water. So you have decided you want insurance, i.e. to protect your family against your passing away prematurely, i.e. the loss of income you represent. Next decide how LONG you want insurance for. If you're around 60 years old, I doubt you want to get any at all. Your income stream is largely over and hopefully you have accumulated the assets you need anyway by now. If you are married and both work, its not clear you need insurance at all if you pass on. The spouse just keeps working UNLESS you need both incomes to support your lifestyle. Then you should have one policy on each of you. If you are single, its not clear you need it at all. You are not sup- porting anyone so no one cares if you pass on, at least financially. If you are married and the spouse is not working, then the breadwinner needs insurance UNLESS you are independently wealthy. If you are independently wealthy, you don't need it because you already have the money you need. You might want it for tax shelters but that is a very different topic. Suppose you have a 1 year old child, the wife stays home and the husband works. In that case, you might want 2 types of insurance: Whole life for the long haul, i.e. age 65, 70, etc., and Term until your child is off on his/her own. Once the child has left the stable, your need for insurance goes down since your responsibilities have diminished, i.e. fewer dependents, education finished, wedding expenses done, etc Do you have a mortgage? Perhaps you want some sort of Term during the duration of the mortgage - but remember that the mortgage balance declines over time. But don't buy mortgage insurance itself - much too expensive. Include it in the overall analysis of what insurance needs you might have. Now, how much insurance? One rule of thumb is 5x your annual income. What agents will ask you is 'Will your spouse go back to work if you pass away?' Many of us will think nobly and say NO. But its actually likely that your spouse will go back to work and good thing - otherwise your insurance needs would be much larger. After all, if the spouse stays home, your insurance must be large enough to be invested wisely to throw off enough return to live on. Assume you make $50,000 and the spouse doesn't work. You pass on. The Spouse needs to replace a portion of your income (not all of it since you won't be around to feed, wear clothes, drive an insured car, etc.). Lets assume the Spouse needs $40,000 to live on. Now that is BEFORE taxes. Lets say its $30,000 net to live on. $30,000 is the annual interest generated on a $600,000 tax-free investment at 5% per year (i.e. munibonds). So this means you need $600,000 of face value insurance to protect your $50,000 current income. This is only one example of how to do it and income taxes, estate taxes can complicate it. But hopefully you get the idea. Which kind of insurance IMHO is a function of how long you need it for. I once did an analysis of TERM vs WHOLE LIFE and based on the assumptions at the time, WHOLE LIFE made more sense if I held the insurance more than about 20-23 years. But TERM was cheaper if I held it for a shorter period of time. How do you do the analysis and why does the agent want to meet you? Well, he/she will bring their fancy charts, tables of numbers and effectively snow you into thinking that the biggest, most expensive policy is the best for you over the long term. Translation: mucho commissions to the agent. Whole life is what agents make their money on due to commissions. The agents typically gets 1/2 of your first year's commissions as his pay. And he typically gets 10% of the next year's commissions and likewise through year 5. Ask him how he gets paid. If he won't tell you, ask him to leave. What I did was to take their numbers, review their assumptions (and corrected them when they were far-fetched) and did MY analysis. They hated that but they agreed my approach was correct. They will show you a 12% rate of return to predict the cash value flow. Ignore that - it makes them look too good and its not realistic. Ask him/her exactly what they plan to invest your premium money in to get 12%. How has it done in the last 5 years? 12? Use a number between 4.5% (for TBILL investments, ultra- conservative) and 10% (for growth stocks, more risky), but not definitely not 12%. I would try 8% and insist it be done that way. Ask each agent: 1)-what is the present value of the payment stream represented by my premiums, using a discount rate of 4.5% per year (That is the inflation average since 1940). This is what the policy costs you, in today's dollars. Its very much like paying that single number now instead of a series of payments over time. 2)-what is the present value of the the cash value earned (increasing at no more than 8% a year) and discounting it back to today at the same 4.5%. This is what you get for that money you just paid, in cash value, expressed in today's dollars, i.e. as if you got it today in the mail. 3)-What is the present value of the life insurance in force over that same period, discounted back to today by 4.5%, for inflation. That is the coverage in effect in today's dollars. 4)-Pick an end date for comparing these - I use age 60 and age 65. With the above in hand from various agents, you can see fairly quickly which is the better policy, i.e. which gives you the most for your money. By the way, inflation is slippery and sneaky. All too often we see $500,000 of insurance and it sounds great, but at 4.5% inflation and 30 years from now, that $500,000 then is like $133,500 now - truly! Have the agent do your analysis, BUT you give him the rates to use, don't use his. Then you pick the policy that is the best value, i.e., you get more for your money. Factor in any tax angles as well. If the agent refuses to do this analysis for you, get rid of him/her. If the agent gets annoyed but cannot fault your analysis, then you have cleared the snow away and gotten to the truth. If they smile too much, you may have missed something. And that will cost you money. Never agree to any policy unless you understand all the numbers and all the terms. Never 'upgrade' policies by cashing in a whole life for another whole life. That just depletes your cash value, real cash available to you. And the agent gets to pocket that money, literally, through new commissions. Check out the insurer by going to the reference section of a big library. Ask for the AM BEST guide on insurance. Look up where the issuer stands relative to the competition. Agents will usually not mention TERM since they work on commission and get much more money for Whole Life than they do for term. Remember, figure the agents gets fully 1/2 of your 1st years premium payments and 10% or so for all the money you send in over the following 4 years. Ask them to tell you how they are paid- after all, its your money they are getting. Now why don't I like UNIVERSAL or VARIABLE? Mainly because with Whole Life and with TERM, you know exactly what you must pay because the issuer must manage the investments to generate the appropriate returns to provide you with the insurance (and with cash value if whole life). With UNIVERSAL and VARIABLE, it becomes YOU who must decide how and where to invest your premium income. If you guess badly, you will have to pay a higher premium to cover those bad decisions. The insurance companies invented UNIVERSAL and VARIABLE because interest rates went crazy in the early 80's and they lost money. Rather than taking that risk again, they offered these new policies to transfer that risk to you. Of course, UNIVERSAL and VARIABLE will be cheaper in the short term but BE CAREFUL - they can and often will increase later on. Okay, so what did I do? I bought both term and whole life. I plan to keep the term until my son graduates from college and he is on his own. That is about 11 years from now. I also bought whole life (NorthWest Mutual) which I plan to keep forever, so to speak. NWM is apparently the cheapest and best around according to A.M.BEST. Where do you buy term? Just buy the cheapest policy since you will tend to renew the policy once a year and you can change insurers as each time. Also: A hard thing to factor in is that one day you may become uninsurable just when you need it, i.e. heart attack, cancer and the like. I would look at getting cheap term insurance that is a bit more but then you can keep renewing, even if ill, or you can convert to whole life. Last thought. I'll bet you didn't you know that you are 3x more likely to become disabled during your working career than you to die during your working career. How is your short term disability insurance looking? Get a policy that has a waiting period before it kicks in. This will keep it cheaper. Look at the exclusions, if any. ----------------------------------------------------------------------------- Compilation Copyright (c) 1992 by Christopher Lott, lott@informatik.uni-kl.de -- Christopher Lott lott@informatik.uni-kl.de +49 (631) 205-3334, -3331 Fax Post: FB Informatik - Bau 57, Universitaet KL, W-6750 Kaiserslautern, Germany